Sigma-Aldrich Corporation Q3 Earnings Call Transcript

Sigma-Aldrich Corporation (SIAL)

Q3 2009 Earnings Call

October 22, 2009

Executives

Jai Nagarkatti - Chairman, President and Chief Executive Officer

Rakesh Sachdev - Senior Vice President and Chief Financial Officer

Kirk Richter - Treasurer and Investor Relations Contact

Analysts

Dan Leonard - First Analysis

Quintin Lai - Robert W Baird.

Michael Sison - Keybanc

Dmitry Silversteyn - Longbow Research

John Roberts - Buckingham Research

Isaac Ro - Leerink Swann.

Rafael - UBS

Presentation

Operator

Good morning, my name is Elizabeth and I will be you conference operator today. Today’s conference is being recorded. At this time I would like to welcome everyone to the Sigma-Aldrich Third Quarter 2009 Results Conference Call. (Operator Instructions). I will now turn the call over to Mr. Kirk Richter, Treasurer and Investor Relations contact. Please go ahead sir.

Kirk Richter

Thank you Elizabeth and good morning and let me also add my welcome to Sigma-Aldrich’s third quarter 2009 earnings conference call. With me today are Jai Nagarkatti, our Chairman, President and CEO, and Rakesh Sachdev, our Senior Vice President and Chief Financial Officer.

After my introductory comments, Rakesh will review our third quarter performance and full year 2009 outlook. Jai will follow that with comments on our performance, our full year 2009 outlook, market conditions, and a review of other activities we plan to launch in the fourth quarter in an effort to address the challenges in our markets.

After completing those reviews, we'll open up the call for your questions and comments. We will be using a slide presentation as part of today’s call. That presentation can be viewed by accessing our Investor Relations website on sigmaaldrich.com.

Before we begin these reviews, I do need to remind you that today’s comments will include forward-looking statements about future activities and our expectations for sales, earnings, cash flow, and other possible future results.

While we believe these expectations are based on reasonable assumptions, actual results may differ materially due to any number of factors, including the risk factors listed in our Annual Report on Form 10-K for the year ended December 31, 2008 and in the cautionary statement that is included in today's release and in our slides.

We have no plans to update these forward-looking statements after this conference. Also SEC regulations require us to provide information on any non-GAAP financial measures covered in today's conference.

That information which consists of currency and acquisition adjusted sales growth, profit and EPS results on both the pro-forma and reported basis, and free cash flow reconciled net cash provided by operating activities is also contained in today's earnings release, which is posted on our website.

Now, I’ll ask Rakesh to begin our review. Rakesh?

Rakesh Sachdev

Thanks Kirk. I'm pleased to report a number of new quarterly highs for 2009 in our third quarter results. As indicated in today’s release, third quarter sales of $534 million, our best quarter in 2009, due to both improved organic growth over prior quarters and less of a currency headwind from that experienced in the first two quarters of 2009.

Our third quarter net income of $86 million and diluted earnings per share of $0.70 exceeded the amounts we reported for both the first and second quarters of the year. And finally our free cash flow in the third quarter of $115 million was the best quarterly results since the beginning of 2008.

Reported sales for the third quarter were 1% or about $7 million above last year's third quarter. The adverse impact of currency reduced reportable sales by 3% and organic increase in research sales of 1.4% coupled with the 4.8% organic increase in our SAFC sales resulted in an overall organics sales gain of about 2% for the company.

Currency was again a significant headwind and reduced our earnings, but we were able to offset the impact and report higher net income and EPS in this third year's quarter compared to last year's third quarter.

Our third quarter net income exclusive of a $12 million currency impact was up 20% from last year's third quarter as we delivered on our process improvement benefits and managed cost to offset the currency impact.

And we realized tax benefits from statute expirations and the timing of R&D tax credits. That translated into a 9% gain in our reported diluted EPS for the third quarter, helped partially by our share repurchases in addition to other factors that I just mentioned.

Excluding the negative impact of currency diluted earnings per share would have been $0.80 representing a 25% increase. I'll have more comments on our sales and income results shortly.

We also generated another $115 million of free cash flow in Q3 to bring the year-to-date results to $274 million. I'm also pleased to announce that we are raising our free cash flow guidance for all of 2009 to be in excess of $325 million, up from our earlier guidance of an excess of $300 million and the $314 million we achieved in 2008.

Going to the next slide, you may recall that for the first six months of 2009, we had reported sales decline of 10%, all driven by unfavorable currency exchange rates. With the stronger organic growth of 2% that we experienced in the third quarter, coupled with less currency headwinds, our reported sales decline for the next nine months was reduced to 7%.

And we expect that momentum to carry over to this year’s final quarter making us comfortable with our forecast of low single-digit organic sales growth for all of 2009. Our year-to-date reported net income reflects the continued negative impact of currency that was more than offset by benefits from our supply chain initiatives, lower SG&A costs, favorable pricing, and the third quarter tax benefit that I mentioned earlier.

Our diluted earnings per share grew even faster than net income with the help from our share repurchases that provided a $0.08 benefit in this nine-month period. And the improved free cash flow in the third quarter drove the nine-month result to $274 million.

That’s an improvement we expect to hold on into the fourth quarter and that enabled us to increase the free cash flow forecast for the full year to an excess of $325 million. We go to the next slide, let's now review our sales performance for the third quarter and the first nine months of 2009 in some more detail.

The organic growth and research sales in the third quarter reflects the improved performance of our lab essentials and analytical chemistry products, as well as our cell signaling and synthetic DNA sales from our research biotech business units, that helped offset a continued weakness in some segments of our specialty chemical products in the U.S. and Europe.

Research sales to universities continued to be stronger than sales to commercial accounts. Overall research sales performance in Q3 was in line with our first half results, exclusive of currency impacts.

In our SAFC business, we experienced nice growth in sales for our custom pharma and biosciences products driven by demand for adjuvant products for the H1N1 vaccine production and industrial media for pharmaceutical customers.

This was also helped by new customer facilities coming online, new financing becoming available at both biotech and virtual pharmaceutical companies and our customer’s efforts to push early stage clinical trials in response to indications of moderate economic improvements.

The growth was partially offset by continued weakness in demand for our niche high-tech products for the solar and semiconductor industries. And while the comparison for our SAFC business is against a weaker third quarter of 2008, relative to the earlier quarters of 2008, we again experienced a sequential increase in sales in the third quarter over the second quarter of 2009, just as we did in the second quarter over the first and our booked orders for future delivery remains strong. As you can see in this margin analysis, our overall pre-tax margins for Q3 were slightly below where it was in last year’s third quarter.

We again faced currency headwinds relative to last year's third quarter that reduced our margin by about 2.5%. Additionally, we saw a slightly higher mix of SAFC sales that resulted in a small margin dilution as our SAFC margins are somewhat lower than our research margins.

We've been able to largely offset these impacts with our supply chain process improvement initiatives and reductions in SG&A spending. As indicated earlier, we continue to generate strong cash flow and we are on track to again generate more than $300 million in free cash flow in 2009. We have now raised our free cash flow guidance all of 2009 to be in excess of $325 million based on our third quarter results. The primary driver was our working capital management. Here we were able to reduce that cash use by $73 million from last year's first nine months. A $20 million improvement from what we reported just one quarter ago. This improvement is largely driven from lower inventory levels as the benefit from our supply chain initiatives continue to focus on ways to reduce inventory without sacrificing service levels.

We've increased our expected capital spending for 2009 by $10 million to $120 million reflecting our ability to complete expansions in Israel and the U.S. earlier than expected. Consistent with what we reported previously we have not encountered any change in our ability to place short-term debt in the U.S. or international markets.

$100 million of our debt is due in September 2010, so we will evaluate our borrowing needs and structure as we turn the corner in 2010. We feel we have a strong balance sheet and have sufficient cash and borrowing capacity to adequately fund our operations and make selective acquisitions.

Our EPS expectation for all of 2009 has improved slightly from what we reported at the end of the second quarter. Our organic sales growth expectation remains in the low single-digits. At current rates, currency will likely reduce that by about 4%, slightly below the 5% impact that we reported one quarter ago. Currency will continue to challenge operating income and EPS in the fourth quarter with an expected impact for the full year of 2009 of about $0.40.

Based on our sales expectations, continuation of our cost improvement assets, current exchange rates our belief is that our markets will not change much from what we have experienced in the first nine months of 2009 and an effective tax rate for 2009 of approximately 30%, we’ve increased our diluted EPS expectation for 2009 from slightly over last year’s $2.65 to be slightly in excess of $2.70.

Now I will ask Jai to complete our review with comments on the drivers of our third quarter results, our 2009 forecast and some new initiatives. Jai?

Jai Nagarkatti

Thank you Rakesh, and good morning everyone. Let me start by saying that I am pleased with our third quarter performance in a continued challenging economic climate.

We saw positive benefit from a number of initiatives launched at the beginning of the year, and after four quarters of declining volumes in our SAFC business driven largely by the economic conditions, we saw organic sales growth in the third quarter for that business.

We expect this trend to continue in the fourth quarter and overall organic sales growth for SAFC for the year should be in the positive column. Let me review just a few highlights of our accomplishments in the third quarter that we believe provides support for our full year expectations.

Sales through our e-commerce channel continued to grow and rose to a new high of 46% of research sales, up from 45% just one quarter ago as we launched new initiatives and increased contents on our website.

We have averaged over 20,000 new registrations each month in the third quarter and have added over 70 new direct business-to-business connections in all of 2009. We had a record number of 3 million visits to our website in September 2009, which is about a 10% increase from September of last year.

We continued to increase content and information on our website such as the new version of Your Favorite Gene. We made good progress on expanding our service and presence in emerging economies, enabling us to grow sales at a faster pace in these markets.

Our expanded distribution center in China opened in September enabling us to enhance our ability to provide unsurpassed service to customers in this fast growing economy. Excluding the impact of currency, third quarter 2009 sales growth in the capital countries exceeded other geographic regions with a 11% gain in research sales, up slightly from the 8% achieved in the first half of this year.

In our focused markets of India, China and Brazil, overall organic growth in the third quarter was 23% with organic sales growth of 10% in India and 34% in Brazil. Third quarter of 2009 reported organic sales in China improved by 58% from the third quarter 2008 levels, reflecting the impact of Olympics in that country last year, driving the year-to-date gain to 22%.

Within our SAFC unit we continue to see a strong indicator of future growth in our booked orders for future delivery. We delivered a fair amount of what was booked at June 30^th, in the third quarter, but our order book remains above 25% higher than what it was at the end of 2008.

These booked orders improved some significant additional orders from several large pharma accounts for products used to produce the H1N1 flu vaccine as well as proprietary industrial cell culture media. Based on these booked orders and their expected delivery and other SAFC business, we now expect SAFC to achieve low double-digit organic growth in the fourth quarter of this year.

Our supply chain initiative continues to be an important contributor to our improved profitability and ability to offset the currency headwind. We achieved another $5 million in pre-tax benefits in the third quarter brining the year-to-date total savings from this initiative to $18 million.

Coupled with our cost management initiatives, a contribution from our share repurchase program and the tax contribution that Rakesh mentioned earlier we were able to more than offset that $0.10 per share currency impact on our third quarter earnings per share.

Earlier this month, we announced an expansion of our relationship with Sangamo BioSciences in the zinc finger nucleus technology platform, which is a cutting edge gene editing tool. This unique technology will be a core component of Sigma-Aldrichs growth strategy into high-value biologic tools.

The expansion of our licensing agreement now includes the capability to provide genetically modified cell line for the production of therapeutic proteins, vaccines, and transgenics taking us into markets with enormous commercial potential. This is on top of our July announcement of the use of this technology to provide genetically modified animal models that enable researchers to study human disease.

We are also pleased that research from the initial success of this technology platform has enabled us to collaborate with the Michael J. Fox Foundation in the form of a research grant to develop more accurate preclinical models to study Parkinson's disease.

After a development period that should be approximately one year, we then expect to make the models accessible to scientists in the Parkinson's research community to speed basic research and drug development efforts.

In August, we announced the acquisition of a chem–informatics company, ChemNavigator Inc, a leading provider of discovery research informatics software tools used for design, selection, and procurement of chemical compound libraries.

This acquisition links ChemNavigator's comprehensive suit of virtual screening and selection tools, an industry leading searchable database of over 16 million compounds with Sigma-Aldrich's core strength in chemical compound management, procurement, and global distribution to facilitate and accelerate discovery research programs. These are exciting times in the life science area and for our company and we fully intend to take advantage of these and future opportunities to drive above market growth and profitably.

Now that brings me back to our forecast for 2009. Rakesh has already discussed our current expectations of low single digit organic sales growth, diluted earnings per share slightly above the $2.70 mark and free cash flow in excess of $325 million.

Let me assure you that the entire Sigma-Aldrich team is committed to achieving these results and I look forward to reporting that in our conference call next February. Looking ahead, we believe that there will continue to be uncertainty around the timing and extent of the global recovery. Several of our markets will continue to be challenged. In this environment, we will be focused on areas that we can influence and those that should drive positive results for the company.

Let me give you a high level overview of what we are focusing on. We are adding new initiatives to our core chemistry and biochemistry business in each of our research based business units. We are increasing our emphasis on higher growth opportunities that exist in the research biotech and analytical products for research. These product areas have become a greater part of the overall research market in recent years. We’ll continue to pursue opportunities in faster growing economies and e-commerce to supplement the product driven initiatives. We also plan to build on and drive additional savings from supply chain process improvements that we have launched about 2 years ago.

We also believe there will be long-term margin enhancement opportunity from some of the top line growth and cost control initiatives. I want to thank you for your continued and ongoing interest in our company. We continue to be a leader in the life science and high technology markets we serve and remain committed to deliver superior returns for our employees and shareholders.

On behalf of Rakesh, Kirk, and all of our colleagues around the world I want to thank you for joining us this morning, now let's open up the call for your comments and questions.

Question-and-Answer Session

Operator

(Operators Instructions). Your first question comes from Dan Leonard - First Analysis.

Dan Leonard - First Analysis

My first question is on your research business. I realize that performance was in line with your expectation, but the growth rate actually weakened a bit from the first-half 2009 growth rate, which isn't consistent with the results we're seeing from other companies. So is there anything specific going on in your research business you believe?

Jai Nagarkatti

Well, Dan fundamentally there is no change in the research end markets. Some segments within the research markets are growing at a faster rate than others. We are also seeing some shift has worked from the large pharma gets moved from the West to the East. So there is no question in the first nine months of the year in certain segments of the research markets, the volumes have actually declined.

Dan Leonard - First Analysis

Okay and then, the research models business, you've been talking lot about it. How large do you think the addressable market opportunity is for you in research models?

Jai Nagarkatti

Again, it’s early days Ben, we have started off and focused only on targeted models involving rats. We are going to leverage our ZFN technology to build a few models, which are going to be off the shelf and focus primarily on making custom models for the large and this medium pharma companies. At this point, before we have a very definite idea of the type of interest in these new models, it will be completely speculative to estimate markets that don’t exist.

Dan Leonard - First Analysis

For example, are you targeting a trial for every type of market opportunity ultimately or you looking at approaching it in more of a niche fashion?

Jai Nagarkatti

We are going to start off in a niche fashion and then let's see where it takes us.

Operator

Your next question from Quintin Lai - Robert W Baird.

Quintin Lai - Robert W Baird

With respect to kind of maybe a pacing question, can you talk a little bit about how sales progressed through the July, August, summer months and then to September?

Rakesh Sachdev

We started the quarter reasonably strong, July was okay, it was encouraging. August, frankly was little weaker than we thought, and but then September ended up quite strong.

And Europe always has shutdowns and vacations in August but it was little weaker than we had seen earlier but September again both on the research side as well as in the SAFC side, we saw some strength that we haven’t seen before. So one month doesn’t make a trend. But we were encouraged with what we saw in September.

Quintin Lai - Robert W Baird

And then with respect to the pricing, maybe what you saw overall and then did you see any differences maybe on some of your more proprietary high end components versus some of your commodity components?

Rakesh Sachdev

Not really. As far as pricing, we had a somewhat larger than normal price increase last year. Our pricing strategy this year is to get back to normal levels. And I think as we have said, we on average get about 2% of price increases. And it’s again not the same across the board. We look at our proprietary products, where we can price a little higher. On the commodity products we can’t.

Quintin Lai - Robert W Baird

And then finally, just at a very high level. In the past you’ve talked about trying to target acquisitions to maybe be about 3% for revenue growth. Based on what's happened here in the market and the dip and now the rebound, going forward is that still a target for you or have things changed in your mind?

Jai Nagarkatti

Quentin this is Jai. I think we are obviously always looking at acquisitions which will add technology and are in keeping with our strategy. But I would not give you a specific target like a percentage that we are going to be shooting for.

But definitely stay tuned, we are looking at acquisitions. We have announced something like the (inaudible). Like they have always done, we also get into licensing deals, expanding our positions like we did with Sangamo and we will continue to do that.

Operator

Your next question comes from Michael Sison - Keybanc

Michael Sison - Keybanc

Just curious with SAFC given that you feel that the full year could be positive in terms of growth, it would sort of imply a pretty big fourth quarter, something to the degree of 10%. Is that how the math works and can you give us a little bit more sort of color on how much of that is sort of baked in or insured if you will with new projects or something?

Jai Nagarkatti

Mike this is Jai. As I mentioned when I spoke a little earlier, the confidence with which we say that we will end SAFC for the year in the positive to offset the significantly negative first and second quarter is based on the fact that the fourth quarter has to be low double digits growth.

And we base that on the orders that we have or in progress being worked in the plant. Now unless something dramatic happens in the plant, our plan is to deliver on those products.

Now a substantial amount of that is tied to our orders that we received in two specific areas. One is adjuvant for the H1N1 vaccine and also some of the proprietary industrial cell culture media orders that are in the drug development stage and the demand for that is steadily increasing.

Michael Sison - Keybanc

Does the H1N1 business or product lines, maybe give us a little bit color what else you do in that and is that sort of like a third or half of that growth in the fourth quarter?

Jai Nagarkatti

Again it would be substantial without throwing some numbers at it. It would account for more than half of the growth. Let's put it like that way.

Michael Sison – Keybanc

Sort of a top line question, if you think about the economy, there is a sentiment that it's improving and maybe they were out of the woods here. What part of your businesses would pick up if the economy is sort of on the right track?

Jai Nagarkatti

I mean, this is a general question that keeps getting asked, so let me kind of tell you where what we feel on this whole issue. We believe that based on what we are seeing, the markets are not clearly going to turn around dramatically anytime soon. But, we will obviously be -- continue to be focused on activities that will create revenue.

That means, focusing and doing things in certain areas like the emerging new areas in the biotech where the growth is going to be more than in traditional chemistry, analytical testing of some areas where we will concentrate, then also trying to focus even greater effort on emerging markets where these markets are still robust. So, doing a lot of the things even in markets that are challenged. So having said that, we will remain focused on driving top line growth through introduction of innovative products and focusing on targeted areas within life science.

Michael Sison – Keybanc

Your balance sheet is in really good shape here, are there any meaningfully sized acquisitions out there that if it all came together correctly would make sense for you to leverage your balance sheet to add one of those?

Rakesh Sachdev

So Mike, as Jai just mentioned, we obviously keep looking at selective acquisitions. We have been kind of quiet over the last 12 months obviously for obvious reasons; there has been lot of volatility.

But again our preference would be still and still to look at bolt-on acquisitions, smaller bolt-on in certain areas as we have talked about and whether it’s in the biotech area, the analytical area or emerging markets and I think we will probably see some of that happening over the next 12 months.

Operator

Your next question comes from Dmitry Silversteyn - Longbow Research

Dmitry Silversteyn - Longbow Research

Can you give me an idea of what the foreign exchange benefit is expected to be in the fourth quarter providing currency stays at current levels in terms of earnings?

Kirk Richter

Well in terms of earnings it’s actually still going to be negative in the fourth quarter. We will see a positive at the top line, but as we've talked about before with the mismatch of our manufacturing in the U.S. and sales outside the U.S. And that movement through inventory, we took what was $0.34 for the first nine months and we said that should still be about $0.40 for the full year. So still a negative impact in Q4.

Dmitry Silversteyn - Longbow Research

Okay, so it won't be until 2010 that you'll start?

Kirk Richter

That’s right. Until we turn the corner.

Jai Nagarkatti

And that’s true.

Dmitry Silversteyn - Longbow Research

As you get into 2010 and obviously a lot of the SG&A cost cutting that you've done probably will not be sustainable going into 2010 but some may be, have you had a chance to take a look and see what you will have to reverse and what you can perhaps hang on to in 2010 so that currency will not be totally offset by increasing SG&A expenses?

Jai Nagarkatti

Dmitry, I think we have said before, we think that at least 60% or 70% of the cost reductions that we have made this year are there to stay, because we have fundamentally changed some of the ways we are doing business more efficiently. So I think you can expect at least a good part of that benefit to continue next year.

Dmitry Silversteyn - Longbow Research

So that’s outside of the supply initiative?

Jai Nagarkatti

I'm talking about SG&A, outside of the supply chain, and again the supply chain and the process improvement to the journey it doesn’t – it didn’t begin and end at the end of this year. We are going to continue to look for benefits next year and the years to follow.

Dmitry Silversteyn - Longbow Research

Then final question on SAFC, you talked about the meaningful positive impact you're going to get from H1N1, a little bit in the third quarter moreso in the fourth. As we get into 2010 are you seeing enough improvement in the fundamental of the addressable end markets to have some kind of an outlook on SAFC going forward?

Are we through the declines that we saw through the first nine months of the year this year and we're going to get back to reasonable growth in that business or has something changed fundamentally where the 10% target that you have outstanding there for a long-term may no longer be achievable?

Jai Nagarkatti

I think Dmitry, this is Jai. I think of course we didn't take it as we get it. So certainly H1N1 is going to continue in 2009 fourth quarter and some of it would even flow into early parts of 2010, but having said that, the rest of the SAFC business has not dramatically changed. We have seen signs of increased quote request coming over there from the small and emerging biotech company which is an emerging and encouraging sign. So, not immediately going to change the market dynamic significantly.

Dmitry Silversteyn - Longbow Research

Okay and then the final question, recently we've had the closure of the large merger in the pharmaceutical area, usually you have a little bit of maybe two or three quarters after that where the activity dies down in the combined entity in terms of research spending.

So, should we get the clock counting or should we start the clock counting for the two or three quarters going forward and expect to see a little bit softer demand from the pharma market on your research chemical side?

Jai Nagarkatti

I think Dmitry you are answering your own question, absolutely, I think what happens is whenever these type of mergers do happen, for a couple of quarters there is a lull in the activity till the pharma companies rationalize who wants to do what projects. I mean, in fact for those of you who are interested there is a most recent article in the October 16^th issue of the Chemical and Engineering News, which specifically talks about the number of researchers, number of employees among that researchers that will be impacted by these major acquisitions that were announced. So certainly in that segment we will continue to see further challenge till things settle down.

Dmitry Silversteyn - Longbow Research

So a little bit of a weakness in terms of year-over-year growth performance that you saw in the third quarter compared to the first half of the year probably will continue for maybe?

Jai Nagarkatti

A couple of more quarters, yes.

Operator

Your next question comes from John Roberts - Buckingham Research.

John Roberts - Buckingham Research

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Few of the major drug companies I think have put some of their manufacturing operations up for sales or at least they’ve been rumored to be exiting some of the manufacturing.

Is that something Sigma would be interested in, I assume you could probably use any of the facilities more flexibly than some of the captive drug companies who don’t?

Jai Nagarkatti

John, at this point I think we have plenty of capacity and some of our own capacity is coming online on some of the projects that we have initiated the last year and a half or so. So at this point we’ll keep watching if there is something good available, we will obviously pursue it but we are not planning on going after that.

John Roberts - Buckingham Research

With the large number of drugs going generic over the next couple of years, will that increase the volatility of SAFC at all? I don’t think there is any one particular drug we focus on for SAFC. But we've got so many over the next couple of years?

Jai Nagarkatti

Yeah, actually now to clarify we really do not make final dosage form of a number of these drugs. Having said that there are lot of products and intermediates that even the generic companies would need and obviously we would be definitely interested in supplying and making products for them. So what turns out as a challenge can also be an opportunity.

John Roberts - Buckingham Research

But is it more competitive in the ingredients for the generic version than one it was a patent version. I expect there are more other companies looking for that same business.

Jai Nagarkatti

Absolutely, that will be one of the things, so ability to make that more competitively is where the differentiation lies.

Operator

Your next question comes from Isaac Ro - Leerink Swann.

Isaac Ro - Leerink Swann

First one would be on the knockout rats. I'm thinking about sort of how that market is structured today with as I understand the majority of knockout mice being both developed and used in house in the drug industry.

So it seems to me part of market where you are displacing a competing vendor and you are really more competing with the internal R&D group in a given drug company.

So I'm wondering given all the disruption within pharma due to the M&A environment I'm wondering if you could walk us through your general sales strategy there as you try to tap into that opportunity?

Jai Nagarkatti

First of all there is a couple of things that we need to also clarify here guys. I think the thing is the models that we are talking about right now are in the rat models, which are distinctly from what I have told different in terms of how drug tox studies are done in rats which may make more humans than mice.

So these are markets that are presently not available, so these are newer to a great extent newer markets and so that's why earlier when somebody asked a question how large this is, we have some estimates, but quite frankly we have to wait and see.

Now the model would be, the way we are selling this is, going after more of educating and informing people on the capabilities of zinc finger nucleus knock out off the shelf products. And then if somebody would be interested in having us make some customed mice, we will take and begin and have begun those projects right away. And based on the demand and what we learn, obviously we will have some off-the-shelf models. But that’s longer term.

Isaac Ro - Leerink Swann

And then if I can just sort of drilling down into the numbers in the near term for gross margins and I apologize if I missed this in the early part. But I'm wondering if you could kind of break down the components this quarter as it relates to sort of the impact to gross margins from FX versus the mix shift in SAFC. I know you mentioned a 2.5% impact, I wasn’t sure exactly what that referred to?

Jai Nagarkatti

So I think if you looked at the slide we just went through and we've talked about pre-tax profit margin which is kind of, you could use that as a way of explaining whether to use gross margin or pre-tax. But a little over 200 basis points was a negative headwind on margins from currency and then you can see that we had a positive impact of about 1.3% from supply chain and then SG&A was almost 1% and then R&D and interest expenses was a smaller piece.

But I would say that if you look at, if you take the impact of currency out, our operating margins would have been about 150 basis points, a little over 100 basis points better than last year.

Operator

Your next question comes from Rafael - UBS.

Rafael - UBS

This is Rafael in for Derik, just a couple of question from me. First one, I may have missed this in prepared remarks but have you (inaudible) your supply chain initiative benefit goals for the year and that you were giving for about $30 million for the year and you're at $80 million year-to-date?

Jai Nagarkatti

So the supply chain process improvements, we have some additional process improvement, let me say PI. So far we have done I think we announced this morning $80 million and we are expecting maybe another $5 million to $7 million in the fourth quarter.

So we are still shooting for about $25 million. There are some other side improvements that we've not baked in this. So if we get those as we are expecting to get those, we are still looking at -- in total the benefits you get from productivity and supply chain will be about $30 million.

Rafael - UBS

Okay, and also looking ahead into 2010 with the current currency factor that you are having, what kind of tail wins can we anticipate into 2010 just rationally, especially where the $0.40 dragged in on the bottom line?

Jai Nagarkatti

I think we'll bake that inas we have in the past based on year end rates where we give our full guidance for 2010, it's hard to isolate that component right now.

Rakesh Sachdev

We will have some tail wins and we'll try to mention that for you in the coming few weeks and months.

Operator

With no questions remaining I would like to turn the conference back over to speaker today for any additional or closing remarks.

Jai Nagarkatti

Sure, we want to certainly thank everybody for their participation today. Looking forward we do expect to release results for the fourth quarter of 2009 before the market opens on the February 10^th of 2010 and as we have this morning. We will follow that with a conference call that same day at 10'O clock Central time.

That concludes today's conference.

Operator

That concludes today's call and we thank you for you participation.

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[algo41:]

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Oct 22 08:16 PM

[Rachel Tova...:]

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Oct 25 05:44 AM